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Bankers say the tax break is an unfair advantage for large credit unions. Now they see an opportunity to get rid of it as lawmakers begin work on a major overhaul of the tax code.

WASHINGTON — Credit unions have been snatching customers from banks amid consumer frustration over rising fees and outrage over Wall Street’s role in the financial crisis.

Now banks are fighting back by trying to take away something vital to credit unions — their federal tax exemption.

With fast-growing credit unions posing more formidable competition to banks, industry trade groups are pressing the White House and Congress to end a tax break that dates to the Great Depression.

“Many tax-exempt credit unions have morphed from serving ‘people of small means’ to become full-service, financially sophisticated institutions,” Frank Keating, president of the American Bankers Assn., wrote to President Obama last month.

“The time has come to abolish this exemption,” Keating said in the letter, which was part of a blitz that included print and radio ads in the nation’s capital.

Bankers long have complained the tax break is an unfair advantage for large credit unions. Now they see an opportunity to get rid of it as lawmakers begin work on a major overhaul of the tax code that is aimed at eliminating many corporate exemptions and lowering the overall tax rate.

The exemption cost $1.6 billion this year in taxes avoided and would rise to $2.2 billion annually in 2018, according to Obama’s proposed 2014 budget.

In a 2010 report on tax reform, the President’s Economic Recovery Advisory Board said eliminating the exemption would raise $19 billion over 10 years and remove the credit unions’ “competitive advantage relative to other financial institutions” in the tax code.

Credit unions said the effort to take away their tax exemption was simply an attempt to stifle competition and remove one of the only checks on bank fees for consumers.

And it comes as some in Congress are pushing to loosen regulations on credit unions so they can expand their business further, including legislation that would lift a cap on the amount of money they can lend to businesses.

The tax exemption is crucial to credit unions, which by law can’t raise capital through public stock offerings the way that banks can, said Fred R. Becker Jr., president of the National Assn. of Federal Credit Unions, a trade group with about 3,800 federally chartered members.

“They’ll have to convert to banks, which is what the banks want,” he said. “Then they’d have, for lack of a better term, a monopoly.”

A 2012 economic study commissioned by the trade group found that removing the tax exemption would cost consumers about $10 billion a year through higher fees and interest rates on loans, as well as lower interest rates on savings.

That loss of income would end up costing the federal government $1.5 billion a year in lost tax revenue, the study said.

Under a 1934 law, Congress exempted credit unions from federal income taxes as long as they were nonprofit businesses, organized without capital stock and operated for the benefit of their members.

For decades, most credit unions were small operations, usually serving employees of individual businesses and government agencies.

The industry has grown significantly since the 2008 financial crisis, boosted by outrage over Bank of America‘s 2011 plan to impose a $5 monthly fee for debit card use.

Bank of America ditched the plan after protests from customers, lawmakers and the White House. But the controversy led consumer groups to launch an effort to get customers of big banks to switch to smaller institutions, such as credit unions. And the effort helped.

By the end of March, credit union membership surged to 95.7 million, an increase of 2.7 million from the start of 2012, according to SNL Financial. The growth in those five quarters was more than in the previous 11 quarters combined, the trade publication said.

Navy Federal Credit Union, the nation’s largest, increased its membership 10.2% to 4.3 million in the year ended March 31. according to SNL. Such large credit unions, which have ramped up their advertising to lure new members, worry bankers.

“The banking industry has no problem with competition. We have problems with competition when it’s on an un-level playing field,” said James Ballentine, the American Bankers Assn.’s executive vice president of congressional relations.

“Credit unions have grown into … tax-exempt banks,” he said.

The bankers’ group said 200 credit unions hold more than $1 billion in assets each.

“We have no interest in going after smaller credit unions because they’ve stuck to their mission,” Ballentine said. “For those who have gotten outside their mission, who have grown beyond recognition, they would be in the cross hairs.”

But credit unions simply have been adapting to changing times, Becker of the National Assn. of Federal Credit Unions said. Those serving factories that closed had to find new members to survive. And others, such as Navy Federal, have offered debit cards and other new services in response to their members’ needs, he said.

“The banks would like the credit unions not to offer any services so their customers would come to them,” Becker said.

Credit unions and their supporters in Congress, such as Rep. Ed Royce (R-Fullerton), are pushing to loosen restrictions on the industry so it can better compete with banks. Among the proposals is one to lift the current cap on business lending to 27.5% of total assets from 12.25%. The move would make it easier for small businesses to get loans, Royce said.

The battle over the credit union tax exemption takes away from the broader concern about making it easier for consumers and small businesses to get loans, he said.

“There is a lot that should and could be agreed upon if there was a mutual respect for the unique business models,” Royce said.

But Ballentine said looser restrictions on credit unions would make the playing field more unfair.

“Ask any banker, ‘Should credit unions be allowed to do expanded business lending?’ They’d have no problem, as long as they pay taxes,” he said.

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